KELATS RUSSELL WALKER AND MARK JEFFERY Netflix Leading with Data: The Emergence of Data-Driven Video Reed Hastings, founder and CEO of Netflix, Inc., sat at his desk reviewing the journey Netflix had taken from a small startup to a company that revolutionized the. way consumers viewed movies and humbled entrenched players in the video rental industry. Since its founding during the height of the dot-com boom in the late 1990s, Netflix and its innovative Web-based, home-delivered video rental business model had all but supplanted traditional bricks-and-mortar chains such as Blockbuster and Hollywood Video by the late 2000s. A comparison of the stock prices of Netflix and Blockbuster as of mid-2009 confirmed this—Netilix was trading at nearly ‘$39, compared with Blockbuster's price of less than $1 __ Hastings, although proud of his company’s accomplishments, could not rest on his laurels. Firms such as Amazon, Apple, and Hulu were beginning to allow consumers to stream movies and television shows directly to their computers or home entertainment devices such as the Apple ‘TY, threatening Netflix’s business. Hastings had just met with Netflix’s director of marketing to brainstorm about how Netflix should respond to these threats. They agreed that digital distribution of movies was becoming increasingly important, yet they knew moving Netflix toward video on demand would require significant investments in research and development and operations, in addition to a fundamental restructuring of the organization. Hastings wondered how best to meet these challenges while maintaining Netflix’s profitable core business. The Video Rental Industry ‘The video rental industry in the United States had its beginning in the 1970s. The basis for this new industry was the development of VCR technology. Studios initially resisted the industry, fearing loss of control over the distribution network (at that time limited to movie theaters). In addition, they did not believe consumers would be willing to rent videos. By the 1990s, however, the studios” acceptance of home rental videos was total, as they saw an opportunity to increase revenues from movies that had performed poorly in theaters. Several independent studios that had difficulty promoting their films in theaters became particular supporters of the video rental business. By 2000, DVD technology was allowing studios to enhance the product delivered by adding extra scenes, extended versions, and commentary tracks, thus increasing profitability. By 2010, Blu-ray technology, which enabled the viewing of high-definition video, was challenging DVDs GAOT bye Kellogy Schoo of Management, Norbwescr Univesip. This case was propared by Linas So 10, Sapad Sram 10, a ett dean Peni 10, and Julia Feldmeir "09 under he supervision of Professors Rasell Walk and Mark Jeffry Fear retloped solely asthe bess for class discussion Css ae no intended (0 serve ws endorsement, sources of primary dal, or illustrations of effective or ineffective management. To order copies oF request permission to reproduce maverials, cal} #00-S45- aaa 9531600 ousie he United Stats or Cana) or e-malcustservhbsp harvard No pat of ts pabiation may be produced, sored in areteval system, used i 2 spreadshec, or ansmitid in any frm o; by ny means—electoni, mechanical otocopying, recording. oF eterwise—wihout the pemission of te Kellogg School of Management sre coca ere ve ely a Prot Prabin K Paniga’s PGPMXIB7/Business Anaiytcs at indian nstute of Management Indore em Oct 2018 to Feb 2019.KELAT3 NETFLIX LEADING WITH DATA as the industry standard for movie rentals, although low penetration of Blu-ray set-top boxes limited growth and helped maintain the DVD's position. At the same time, other channels for distributing movies were also gaining supporters. Digital distribution of movies (via Internet streaming) was gaining market share, beginning with younger, more tech-savvy customers. In the medium term, this form of movie distribution was a great threat to the physical rental of movies. In addition to not requiring customers to go to a video rental store or mailbox, digital distribution allowed customers to watch a film immediately after purchase and offered additional features, such as the possibility of downloading movie trailers, which allowed better promotion of movies and greater monetization of some titles (see Exhibit 1 for a financial portrait of the U.S. media entertainment market). The Video Rental Industry Value Chain ‘The video rental industry included several players in its value chain: content creators, distributors, television and cable operators, movie theaters, video rental stores, and retail outlets. After a movie was released by a studio, it was expected to move to home video and pay-cable distribution channels before moving to basic cable and television networks. Traditionally, content creators, or movie producers, had significant control over the pricing and offering of movies. However, the rise of the video rental market greatly reduced the power of large movie producers, providing opportunities for smaller movie producers to prosper while forcing movie prices to be adjusted from the in-theater model to accommodate the in-home movie experience. Industry Players Although the video rental industry was highly concentrated, the market was also populated by a number of regional companies and smaller niche players. For example, eHit targeted the Japanese, Chinese, and Korean communities. Adult DVDEmpire was the largest adult-only rental company, offering a wide range of adult entertainment, Redbox offered online Blu-ray and DVD rentals, but required customers to pick up the discs at kiosks located primarily at grocery stores, gas stations, Wal-Marts, and fast-food restaurants. Several software solutions, such as Graboid, allowed customers to watch movies online. The Rise of Blockbuster Blockbuster Inc. soon emerged as the video rental industry Goliath. Founded in 1985, the chain had quickly become the largest in the world, Growth was primarily through acquisition; the company targeted local video stores with dominant market share, thereby guaranteeing a strong, installed customer base in convenient locations. Firmly rooted in a storefront model, Blockbuster also bought out regional chains, including Southem Video Partnership, Movies to Go, Video Library, and Major Video. In 1987 Blockbuster had 133 stores; two years later it had 1,000. Blockbuster had a traditional video rental business model; it bought the movies? licenses from the studios, stocked the physical products (VHS, DVD, Blu-ray discs) in its central warehouses,KEL473 NETFLIX LEADING WITH DATA, and then nd then spread th ; Videos, Blockbuster sole souebOut IS network of stores and franchisees, In addition to renting Sold other products in its stores, stich as video games and snacks. As ind stry tit ave Blockbuster was an important linkin the major sitio profit chain. Studios Durchase the film outrigh: Sy rentine VHS copies of movies before the general public could all studio income and ight. The result was huge. Sales to Blockbuster represented nearly half of and were a critical source of their high-margin revenue. But thira ie ame in the late 1990s: Blockbuster, which by now had 3,400 stores, nearly one~ time. For the fer bene, fost Key leadership personne! and had dificlly stocking new releases on 1990s was atime, the video giant was vulnerable. The release ofthe DVD format in the late the sama gull. the wound: studios began releasing DVDs to retail channels and rental chains at replaced Breer gyoiPPing Blockbuster of its firstto-rent advantage. Accordingly, Wal-Mart }ockbuster in 2003 as the single largest source of income for studies." As its core business revenues fell : under attack from Wal-Mart and video rental competitors, Bie faced another challenge—this time from an upstart online rental service that mailed vies in eye-catching red envelopes: Netflix. Netflix Netflix was founded in 1998 by Reed Hastings and Marc Randolph, former colleagues at Pure Software, a startup begun by Hastings that was later purchased by Rational Software for $750 million in 1997.? Hastings hatched the idea shortly after he sold Pure Software, when he discovered on a visit to a video store that he owed a $40 late fee for Apollo 13, which was six weeks overdue. Hastings recalled later: Thad misplaced the cassette. It was all my fault. I didn’t want to tell my wife about it. And 1 said 10 myself, “I'm going 10 compromise the integrity of my marriage over a late fee?” Later, on my way 10 the gym, | realized they had a much better business model. You could pay $30 or $40 a month and work out as little or as much as you wanted? Hastings soon hatched a plan to fuse Americans’ love of movies with their desire for convenience. Although Netflix was launched as an online version of a traditional pay-per-rent model, charging $4 per rental plus a postage fee and any incurred late fees, it quickly introduced a monthly subscription model and eliminated due dates and corresponding late fees (see Exhibits 2 and 3 for Netflix’s financial statements). How Netflix Worked ‘The Netflix business model was easy for customers to understand. Customers signed up for monthly subscriptions, choosing among packages that allowed them to rent varying numbers of —— » dward Epstein, Hollywood's New Zombi,” Sle Mazin, any 9, 2006, hp sate com 2995, ° =Puse Software Inc. Announces Initial Public Offering of Common Stock,” Business Wire, August 2, 1995, ‘itp /[Link]/ ticles/mi_mOEIN‘s_1995_August 2/31 17119769 tee Coney, Peak: iow GrctCompames Get Ther Mao fom Masow San Frcs Soya, 207 ee